US Treasury Yields Rise, Posing Risks to Regional Banks and Commercial Real Estate

Since late 2022, US Treasury yields have exhibited an upward trend, exerting pressure on regional bank balance sheets and elevating commercial real estate distress risk.

Impact on Bank Stocks and Loan Default Risk

Smaller bank shares have witnessed an 8.2% decline since late November, coinciding with the upward trajectory of the 10-year Treasury yield. Rising credit costs increase the probability of default for borrowers who acquired office buildings before the pandemic, when values were significantly higher.

Increased Banking System Fragility

"Rising long-term yields render the banking system more vulnerable in the short term," remarked Steven Kelly, associate director of research at the Yale Program on Financial Stability.

Federal Deposit Insurance Corp. Chairman Martin Gruenberg indicated that last year's surge in 10-year yields likely reversed third-quarter declines in unrealized losses for banks' available-for-sale and held-to-maturity securities.

Commercial Real Estate Concerns

Tomasz Piskorski, a finance and real estate professor at Columbia Business School, warns that elevated borrowing benchmarks could lead to higher commercial real estate losses for regional banks. Borrowers may encounter difficulties refinancing, as the value of office and multifamily properties continues to depreciate.

Smaller Lenders' Vulnerability

Smaller lenders face increased exposure to CRE defaults due to their lower down payment requirements. As property values plummet, lenders have a diminished buffer against losses.

Declining Deposit Costs Offer Relief

Lower Federal Funds rates have reduced deposit costs, providing some stability for banks. Steady deposit inflows in the fourth quarter mitigate the risk of depositors moving funds to other institutions, reducing the need for lenders to sell underwater bonds.

Outlook and Potential Mitigation

Analysts generally remain unconcerned about unrealized losses, as forced sales similar to those experienced by Silicon Valley Bank appear unlikely. The incoming administration's possible deregulation policies could also enhance bank margins.

However, Piskorski cautions that the combination of rising borrowing benchmarks and Fed interest rate cuts creates a "precarious position" for banks, potentially exacerbating their fragility.